The European Central Bank’s (ECB) first major climate stress test shows banks facing a hit of 70 billion euros (US$71 billion) from increasing natural disasters and sweeping changes across industries.
The figure totals credit and market losses in the worst scenario, which includes droughts, heat and floods, the ECB said yesterday.
It cautioned that the result “significantly understates” actual risks related to global warming, partly because climate shocks were not accompanied by a broader economic downturns and limited to specific portfolios.
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The ECB also found that 60 percent of banks do not yet have a climate risk stress-testing framework. Most lenders do not include climate risk in their credit-risk models, and just one in five consider it as a variable when granting loans.
“Euro-area banks must urgently step up efforts to measure and manage climate risk, closing the current data gaps and adopting good practices that are already present in the sector,” said Andrea Enria, chair of the ECB’s Supervisory Board.
A total of 104 banks participated in the wider exercise that has been presented as a learning opportunity for banks and regulators alike.
Yet the impact was far softer than many banks had expected and the industry is already using the results to lobby against efforts by some ECB officials keen for lenders to set aside more money to cover climate risks.
Last year’s traditional banking stress test, which modeled economic shocks and took into account the impact of the COVID-19 pandemic, saw almost 400 billion euros of credit and market losses across 50 banks.
Bloomberg reported earlier this week that the toughest hypothetical scenarios in the climate test did not result in losses that would make a meaningful dent in capital buffers at banks.
The ECB said while the results of the stress test would feed into its annual review of risks banks face, there would not be any direct impact on capital through the Pillar 2 guidance this year.
That might change in the future, said Frank Elderson, the Executive Board member who serves as vice chair on the ECB’s Supervisory Board.
“It’s clear that climate-related risks are among our top priorities,” he told reporters during a press conference.
“As with many new, emerging risks, it takes time to properly address them and we understand that. But it’s also true that as all material risks, climate-related factors will eventually be integrated in our risk-based supervisory approach,” he said.
The ECB found that almost two-thirds of banks’ interest income from non-financial corporate customers stems from greenhouse gas-intensive industries, with higher-emitting sectors accounting for 21 percent.
It also criticized that banks “barely differentiate” between various long-term scenarios on climate change, saying they are lacking “robust strategies” beyond reducing exposures to the most polluting sectors and supporting lower-carbon emitting businesses.
“While this is a good first step to closing the data gaps, banks need to step up their customer engagement to obtain more accurate data and insights into their clients’ transition plans,” the ECB said in a statement. “This is a precondition for banks to gauge and manage their exposure to climate risks going forward.”
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